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Recession possible in 2014, says economist

Australia could face a recession within two years unless the dollar and interest rates fall and major labour market reforms are introduced, a leading economist warns.

Saxo Bank chief economist Steen Jakobsen warns that with the mining investment boom expected to peak in 2013, Australian authorities need to do more to ensure other sectors of the economy can pick up the slack.

He fears if no action is taken, then Australians could be staring at a recession in 2014.

"You have an excellent starting point, you have the ability to both fiscally and monetarily support and mitigate the effects of this slowdown," the prominent Copenhagen-based economist said.

"If nothing happens, if we have a political vacuum leading to nothing being done next year and the price (of the Australian dollar) remains above where it needs to be then, yes, absolutely a recession is possible."

Greater workplace flexibility and the abolition of some indirect taxes are necessary to reduce unit costs and making businesses more competitive, Mr Jakobsen says, with a federal election due in the second half of 2013, he knows action on that front is unlikely.

"2013 is a huge year in terms of the decisions that need to be taken but there will be a political vacuum until the election is held, which I think is a wasted opportunity," he said.

So he says the heavy lifting will fall to the Reserve Bank of Australia (RBA), which will need to cut the cash rate sharply to stimulate the economy.

"I think we will have a huge drop in GDP (gross domestic product) in early 2013, everything being equal, but it can be mitigated by an aggressive RBA," he said.

The RBA kept the cash rate on hold at 3.25 per cent in November but futures markets have priced in another half a percentage point in cuts by mid 2013.

But Mr Jakobsen thinks the RBA may need to cut by as much as 1.25 percentage points within a year.

A cash rate of two per cent would encourage consumer spending and would make the Australian dollar less attractive to international investors.

The Australian dollar has spent most of 2012 above the 100 US cent mark but Mr Jakobsen says it needs to be much lower.

"The Australian economy needs an Aussie dollar around 85 US cents to cater for the cyclical downturn and the lack of reforms in terms of creating alternatives to the mining sector," he said.